It is naive at this point to think that any established industry is free from disruption. The combination of the Internet, mobile computing and advanced algorithms should make nearly every business sit up and take notice, if they have not already. The below graph from Carpe Diem shows how this disruption has played out in the newspaper industry. The newspaper industry that was once considered a cash cow has become a shadow of its former self. Despite the many pleasures of reading a daily newspaper consumers and advertisers have voted with their attention and dollars.
One could characterize the rise of ETFs as a disruptive force in the world of investment management. By embracing the twin trends of indexing and lower costs ETFs have shown many investors a new and better way to invest. Financial advisers are now getting on board this trend after having sat it out for some time now. This trend is showing up in growing assets in model ETF portfolios.
This fits with a post by Nick Shalek at TechCrunch entitled: “Thankfully, software is eating the personal investing world.” In this post he talks about how it is that “software is better at investing than 99% of active investors.” Shalek’s point is that we humans are prone to make any number of behavioral errors when it comes to investing. Not only that computer algorithms are programmed to act in the investor’s interest alone, in short as Shalek says they don’t have a vacation home to pay for. So Shalek’s advice to a friend with new found with is this:
Given these realities, there are very few individual investors who can outperform software implementing a low-cost, passive approach. The educated personal investor recognizes her own limitations of time, passion and expertise.
That’s why my advice to my friend from Facebook was to remember how he made all that money. Unless you want to spend all of your time becoming an investor in the public markets, keep it simple and cheap. Determine an asset allocation that fits your risk profile, stick with low cost index funds and ETFs, and let the software do the work. Also, don’t make too many crazy angel investments (unless you want to make one in my new company, in which case give me a call).
On the other hand Leigh Drogen takes issue with the above post. He is skeptical of the business model of the firms vying in this online investment management space. He writes:
While WealthFront, Betterment, SigFig, Personal Capital and others may take money away from the brokers and investment advisors, their don’t really have a business because their margins are going to suck.
At the end of the day these guys aren’t solving a real problem for the market, they are just using software to eat it. And that’s fine if that’s what you call success, but not me.
Which may or may not be true. There is no doubt that there is plenty of fat, 1%+ expense ratios for open-end mutual funds and 1% annual management fees for investment advisers, to fund any number of startups in this space. That being said none of the companies in this space have yet to really take off. Ultimately maybe none of them will. But it is hard to believe that investment management will somehow remain untouched by the mega technology trends currently at work.
However Leigh is also of the underlying premise of the investment management model put forth by most of these firms that emphasize asset allocation and indexing. He writes:
Here’s the real problem that needs to be solved. The discovery and centralization of great active management talent.
Which is in my mind a very different problem altogether. The fact is that great active management talent is rare indeed and by definition cannot be crunched into an algorithm. The sad truth is that for decades individual investors have been playing the active management game and losing. Losing to their own bad behaviors and losing to the many financial intermediaries who have their hands out along the way. That is not say there aren’t great investors out there and that individual investors shouldn’t try to be great investors if it so moves them. It simply means that the math is working against you in the process and that for the vast majority, let’s say 99% of investors, a simple, low-cost approach will prospectively turn out to bet a better bet.
The great achievement any of these emerging online investment management firms won’t be the fees they might save investors or the elimination of unforced investing errors. While important, these things will be ultimately be secondary to the fact that like many online innovations ultimately make consumer/investor lives easier and better.
Items mentioned above:
The newspaper revenue bubble. (Carpe Diem)
Advisors keen for model ETF portfolios. (InvestmentNews)
Thankfully, software is eating the personal investing world. (TechCrunch)
WealthFront, Betterment, SigFig and a bankrupt investing philosophy. (Leigh Drogen)